Finding Small Business Fraud with James Ratley

“The way to prevent fraud is to create a perception of detection.” - James Ratley Share on X

There are a shocking amount of businesses that ultimately fail because of fraud. Many managers and business owners are unaware of their losses because they do not have the systems in place to look for fraud and it may not be their primary concern.

Today’s guest is James Ratley. Jim graduated from the University of Texas at Dallas with a bachelor’s degree in Business Administration. In 1971, he joined the Dallas Police Department as a police officer. He was on numerous task forces with a concentration on major fraud cases. He joined a major forensic accounting practice and was in charge of fraud investigations. 

In 1988, he was named the Program Director of The Association of Certified Fraud Examiners and in 2006, became the President. In 2011, he became the CEO and he retired in 2018 after 30 years there. James has been an adjunct professor, published author, and named by Accounting Today as one of the top influencers multiple times.

“There are no small frauds, only frauds that have not had time to reach maturity.” - James Ratley Share on X

Show Notes:

• [1:14] – James shares his background and the way his career panned out over 30 years.
• [3:35] – When the ACFE was established, there was no information or education around it at all.
• [5:09] – The average organization loses 5% of their revenue to fraud. Out of every ten people hired, statistically, six of them will steal from you.
• [6:46] – Fraud can be prevented and strategies to reduce fraud are typically inexpensive.
• [8:40] – It’s important for business owners not to be afraid to call it fraud.
• [10:25] – Fraud perpetrators believe they deserve what they’ve taken.
• [13:26] – It’s important for businesses to have strong management and leadership. Training is crucial.
• [14:18] – James discusses the most common types of fraud and how even the seemingly minor things could be detrimental.
• [18:24] – Fraud perpetrators are really good at hiding what they are doing and making the business owners believe it could never be them.
• [20:15] – Another strategy is to separate tasks out and be strict about them.
• [21:37] – Surprise cash counts is another good strategy.
• [23:13] – There are no small frauds, only frauds that have not had time to reach maturity.
• [25:44] – You impact rationalization through education.
• [29:16] – James lists some of the red flags that could indicate something more going on.
• [31:31] – There should be policies and regulations that purchasing officers are held to.
• [36:30] – Auditors must be completely independent.
• [40:10] – Some business owners will deny the problem is happening because it is hard to deal with and accept that someone they trust could be stealing.
• [44:35] – Many small organizations go out of business due to operating at a loss. Most of the time this is because of fraud.
• [47:25] – Never judge someone by the standards you have for yourself.
• [51:12] – Something to remember is that most fraudsters will steal in even numbers.
• [53:11] – In most cases that James has worked, the manager had seen all the signs, but never thought anything about it.

“The average organization loses 5% of their revenue to fraud. Out of every ten people hired, statistically, six of them will steal from you.” - James Ratley Share on X

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Transcript:

James, thank you so much for coming on the Easy Prey Podcast today.

Thank you very much for having me, Chris.

You’re welcome. Can you tell myself and the audience a little bit of background about who you are and what you’ve been doing?

Well, Chris, my career started off—I was a Dallas police officer many, many years ago. There, I was fortunate enough to get a real solid background in investigative techniques, interview, and interrogation. Then, in 1986, left the department and went to work for a financial investigative firm in Austin, Texas with a gentleman by the name of Joseph Wells.

In 1988 Joe came to me and he said, “I’ve got this wonderful idea for this thing called the CFE, or the Certified Fraud Examiner.” The long and the short is we created the Association of Certified Fraud Examiners. At that point, we had no members. A matter of fact, we had five employees.

The first announcement of the program, we printed out 20,000 letters on a desktop printer. We stuffed them ourselves, we sorted them, and mailed them. The ironic part about it was our response was overwhelming. Within weeks, the post office was bringing our mail in boxes.

Shortly after we started the ACFE, I looked out in the front yard of the office, and there are two men in suits. I go out there, they’re FBI agents; someone had turned us in for perpetrating a fraud. We brought them in and showed them what we were doing. Both of them became Certified Fraud Examiners. The program was met with overwhelming success. Today there are almost 100,000 members of the Association of Certified Fraud Examiners from over 155 countries.

When we first started the ACFE, there was no information on fraud. I went to the University of Texas library and there were two books there on fraud. Both of them said fraud is really bad and we need to do something about it. That’s where they stopped. There was no information on what to do, how to do.

Joe Wells is the father of all of this. Dr. Donald Cressey was a noted criminologist that wrote and talked on […]. Joe reached out to him, and before long we had reached to a variety of experts and had them write technique. Keep in mind, this was before the Internet. This was before the computer. We created the Fraud Examiner’s Manual, and it was a how-to book on how to deal with fraud and what to do with fraud.

Then we came up with a report to the nation and just a wealth of information. The average organization loses 5% of their gross revenue to fraud. Out every 10 people that you hire, statistically, six of them will steal from you.

The average organization loses 5% of their gross revenue to fraud. Out every 10 people that you hire, statistically, six of them will steal from you. -James Ratley Share on X

Ugh. That’s a scary thought.

Yes, it’s a very scary thought. But at that time in our business community, people wouldn’t even say the word fraud. There was another accounting association; they called it irregularity. Now I’m from East Texas, and the word irregularity has a completely different meaning in Marshall, Texas.

The Association of Certified Fraud Examiners put fraud on the map, and it took it from the back room to the corporate boards. The report to the nation quantified some of the problems that we have. Over half of the frauds that occur, there are internal controls that were there to prevent them, and people ignore them. One of the things with a small business, if you have fewer than 100 employees, you’re twice as likely to become a victim of fraud. In that situation, 51% of business failures are as a direct result of fraud.

One of the things with a small business, if you have fewer than 100 employees, you’re twice as likely to become a victim of fraud. In that situation, 51% of business failures are as a direct result of fraud. -James Ratley Share on X

Wow, I didn’t realize it was so high.

It’s such a massive problem that it can’t be ignored. The great thing about it, Chris, is it can be prevented very cheaply. One of the organizations that I dealt with in my career at the ACFE had a massive fraud problem. We talked, and what they did is they created a fraud squad.

Instead of hiding it and not saying the word fraud, they took pictures of members of the squad and they put them in the newsletter. They said, “Here’s the number to reach these guys. If you know of anything, give these people a call and they’re going to respond to it. We all want to work for a clean corporation.” Just doing that reduced their fraud by approximately 50%.

Oh wow.

People that steal—and very seldom do we ever find anyone that says, “I stole”—come up and say, “I deserve the money. I’m the best employee they had.” We perceive ourselves as we intend to be. Other people perceive us as we really are. The main thing you have to do to prevent fraud is create the perception of detection. You do that by having an anti-fraud program, by talking to the employees about it.

The main thing you have to do to prevent fraud is create the perception of detection. You do that by having an anti-fraud program, by talking to the employees about it. -James Ratley Share on X

Many, many years ago, smokers could sit right in the office with you and smoke. Now they’ve got to run outside, and even if it’s raining, they’ve got to go outside and smoke. Non-smokers don’t care. Non-smokers are happy about that. Fraud is much the same way. If someone’s not stealing, they don’t care what you do to a fraud perpetrator.

If you create a fraud, anti-fraud program, they’re happy with it. They’re fine with it. They don’t even think about it because they’re not involved with it. The first thing that people have got to do to reduce the level of fraud is quit being afraid to say the word fraud.

Got you. Let’s take a step back. You had said that six out of 10 employees have stolen from the companies they work for. Do you mean that they have stolen money, or is it, “I took an extra ream of paper when no one was looking, a box of staples,” or is it high-dollar theft?

They will steal to the limit of what they can. I was doing a class teaching one time for a state auditor’s office, and we got to talking about what is stealing. If you’re working for a company and you take that ream of paper, is that a theft? What I said is, “Not only is it a theft, but if you’ll steal that ream of paper, you’ll steal a million dollars if they give you the opportunity.”

If you have three elements—financial need, which probably everybody has one time or another, the opportunity, which most employees are going to have to steal, but then the third element is the ability to rationalize. -James Ratley Share on X

We know you’re a thief. The only reason you’re not stealing a million is because you don’t have the opportunity. In order for someone to steal, Chris, there are three elements. It’s like the old fire triangle you had when you were in school, a heat-flammable material and oxygen will create a fire. If you have three elements—financial need, which probably everybody has one time or another, the opportunity, which most employees are going to have to steal, but then the third element is the ability to rationalize.

As I said earlier, people don’t look at themselves as the thief; they look at themselves as the best employee the company’s got who is underpaid. I’ve heard time, after time and time again, fraud perpetrators tell me, “I deserve that.” Now, the ability to rationalize is the key figure there, and a company can take that away by education, by explaining to employees, “We’re paying you what you deserve,” and you do it in a nice way.

People don’t look at themselves as the thief; they look at themselves as the best employee the company’s got who is underpaid. -James Ratley Share on X

There are a lot of companies that have excellent fraud-prevention programs, but you educate your employees. The way that you stop them from stealing is by creating the perception of detection. There are a lot of things that go into creating the perception of the detection. You’ve got to have managers.

I did a training, and this was at a huge corporation on the East Coast. The head of the human resources department said it better than I ever could. She was talking to all these people and she said, “If you are a manager, come on; get serious. Be a manager.” That says it all right there. The manager should know what the employees are doing.

I had one manager that told me that when he was promoted to a manager, he would not go to lunch with the other managers. He stayed there and had lunch with his employees because he wanted them to know he was on their side.

This was a good friend of mine, a very close friend of mine. I said, “I love you like a brother, but I’ll never call you a manager because you’re not. You’ve got the title, and you’ve got the pay, but you’re not doing your job as a manager, and you’re part of the problem. Your obligation should be to that company, to that organization, to do your job as a manager.”

So many people won’t do that. They want to be friends with their employees. They won’t take a confrontational role with them because they want to be the nice person. A manager should know what their employees are doing. They should know their job well.

My mother once told me, “Children get their security from discipline.” I think employees do too. If I’m working for a company, I want to know that company’s going to be there five years from now. If we’ve got good managers that are faithful to the company or obligated to the company, that’s going to help ensure the longevity of that organization. So I don’t think it’s very important that you have strong management environment, but you have to train them. That’s what organizations are learning. Training is very important.

We have different types of fraud in the sense that there are physical assets and money. Let’s call it two categories, whether it’s paperclips or inventory or food versus actual either physical currency or electronic currency. What are some of the processes that should be put in, the controls that should be put in place to help on the physical asset side?

The first off, 80% of the fraud you encounter are going to be asset misappropriation. That’s the massive problem that you have there. It’s very important that you separate the care and the control of that asset from the record… Share on X

The first off, 80% of the fraud you encounter are going to be asset misappropriation. That’s the massive problem that you have there. It’s very important that you separate the care and the control of that asset from the record keeping.

That’s why I’m talking about small businesses. That’s why they’re much more susceptible because they don’t oftentimes have their employees, or a number of employees, to separate the control of that asset from the record keeping. You’ll have one person that writes checks to pay the vendors and balances the checkbook, keep the records of the check time and time again.

I always have said that doctors and dentists make excellent fraud victims because they don’t want to run a business. They want to be a doctor or a dentist, whatever. They will take one woman or one person and they’ll say, “All right. You’re responsible for running the office. You pay the bills, you keep the checkbook.”

Oftentimes, it’s a person they’re so dedicated to, that has worked for them for 20 years. They won’t know that they’ve been a victim of fraud until the checks start bouncing. They’ll let that person because that person is writing themselves checks, as you know, is a very, very simple process.

When we first started the association, we did something that was not very popular, but it turned out to be very effective. We would bring fraud perpetrators in to address the people in our conferences. We never paid them. We would make a contribution to their restitution fund. We didn’t want them to benefit from what they had done, but we brought one into Austin and I drew the short straw, and I was going to have to take him to dinner.

So I called my wife and I said, “Barry is coming and we’re going to take him to dinner, and I want you to go.” She said, “I don’t want to go with him. He’ll steal my jewelry.” I tried to tell her in a nice way that he wasn’t interested in the level of jewelry that she had. He wanted something a little bit nicer.

I had met this guy one time for about five minutes, so basically I didn’t know him. We go to pick him up, he gets in the car, and the first thing he does is hit me on the arm and says, “Jim Ratley, why didn’t you tell me you had such a lovely, young wife?” I heard her giggle a little bit. We go to eat and he could tell she was a little standoffish.

He asked her what she did for a living and she told him. He said, “It’s Monday morning at eight o’clock. Take me through your day.” I thought, “Barry, you are killing me. I don’t even know what she does for a living.” But she would say, “Well, I make reservations for the director.” “Oh, is that hard? Do they travel much?” He would ask follow-up questions, and anytime she would say something remotely funny, he would just almost fall out of the chair laughing.

Two hours later, Chris, when we dropped him off at the hotel, we hadn’t pulled out on the street yet when my wife looked over at me and said, “He’s such a fine, young man.” I said, “No, he is not. He stole over $240 million. He doesn’t care what you do for a living, and you were not that funny.” A little word of the wise: Never tell your wife she’s not that funny.

He had won her over with just a sterling personality. So many times that’s what fraud perpetrators do. I’ve had managers when we would go to them and tell them, “This is a person stealing.” “Tell me you’re wrong.” That didn’t happen. Eighty percent is asset misappropriation.

The first thing you’ve got to do is look at the internal controls. Do you have the same person that is responsible for keeping the asset handling the asset that’s keeping the books on it? They’re going to falsify. -James Ratley Share on X

I get a lot of calls and give a lot of tips to managers. The first thing you’ve got to do is look at the internal controls. Do you have the same person that is responsible for keeping the asset handling the asset that’s keeping the books on it? They’re going to falsify. The lowliest employee you have, Chris, knows that the records have to balance. The longer that employee has been there, the more opportunities they have to steal, the less someone watches them.

So many times when we come in and they suspect they have a fraud problem, the first thing I look at is the top performers. They’re the people that outperform everybody else. They’re the people that they say could be anybody except this person. So many times it is that person.

Interesting. I worked for a company that ran a mail order catalog of products back before the Internet. I was always very impressed with their handling of separating everything out.

The person in the warehouse who did receiving was never allowed to ship product and didn’t participate in inventory. Then there was one inventory count team that was warehouse people. Then there was a second count team when we did quarterly or when we did the cycle council stuff that didn’t normally work in the warehouse who’d go out and count stuff.

If there was a discrepancy, two managers would go out together and confirm who was right. We all hated inventory because it was a whole-day ordeal. But it was those things, those extra layers of, “That’s the person who receives it, doesn’t ship it,” and all those things really helped keep the inventory loss down.

That’s what I’m talking about in creating the perception of detection. If you stop doing that, then the employees are going to pick up on that. I went to one company that they collected money. They had this department. They had about 10-15 clerks and people paid the electric bills and stuff such as that. Back then—this was many years ago—a lot of what they collected was in cash.

The company was very diligent in doing surprise cash counts. I’m teaching a seminar to them, and one of the employees raised their hand and said, “We used to do all these surprise cash counts. Then this new director we’ve got has stopped all the surprise cash counts. Why would somebody do that?”

I was getting ready to say, “Because they’re not very smart.” Fortunately, the person spoke up and said, “Well, I’m the new director, and I’m the one that stopped the surprise cash counts.” I said, “All right. Well, answer his question. Why did you do it?” He said, “Because we were never catching enough errors or problems to make it pay for itself. It was never worthwhile, so I stopped doing it.”

Well, six months later I got a call from someone and said, “These employees had been stealing them blind. They had to reimplement and start doing the surprise cash counts again because it didn’t take those employees but a week to figure out that the surprise cash counts had went away.”

When you do that fraud triangle I talked about a while ago—the financial need, the opportunity, and the ability to rationalize—you’ve got that opportunity there. It completed the triangle and let those people come back and start stealing again. Here’s the thing. There are no small frauds, Chris, only frauds that have not had time to reach maturity. I told the class that time, “If you’ll steal that ream of paper, you’ll steal a million dollars.”

One employee came to me at break and he said, “You know that’s ridiculous.” He said, “Everybody in our office, when school starts, they go in and get pens and papers.” I said, “No, they don’t.” I said, “You do and you want to feel better about yourself, so you’re saying everybody does it.” He says, ‘No, they really do.” I said, “Well, there’s your manager over there. Let’s call her over here and ask her if she does it.” “Oh, no, no. I don’t want to do that.”

Once again, they perceive themselves as they intend to be. I perceive myself to be an excellent driver. My driving skills are great. But my wife who rides with me all the time has got much more accurate knowledge of my driving skills. I perceive myself to be good. Other people have a more accurate perception.

I’ve heard that story about drivers that when people are asked if they’re a good driver or a bad driver, 90% of people say they’re a good driver or they’re a better than the average driver.

Oh, they do. The other day I was riding with my wife. I switched/changed lanes and she said, “You really have to signal so people will know.” I said, “I’m doing fine. Leave me alone.” Well, I’m driving along thinking, “Well, she’s actually right.” I hate it, of course, but I couldn’t use the signal the rest of the day because if I did, she’d be right and I’d be wrong.

Humans are very interesting that way. You had mentioned the fraud triangle again. A lot of what we’ve been talking about is effectively reducing the opportunity or making the opportunity a higher risk. I don’t think we could do anything about someone’s financial need. We don’t. People get paid what they get paid. We’re not going to like, “Oh, you’re in financial need, so let me double your salary just because.” We don’t have a whole lot of control over that one. Is there any way to impact the rationalization?

You impact the rationalization through education, through explaining to people. Fraud is always a problem. Another thing that you do, you give them a means to report it if they see it.

The most common thing that companies do is they have a fraud hotline, or they have a hotline where people can call in and report stuff anonymously. That’s very important to give someone a means and a method to turn somebody in. You’re not trying to create a state where people live in fear, but you educate the people. You explain to them that this is why we have this hotline. We want this company to be as healthy as we can for all of us.

I’ve worked around people that didn’t carry their load. Other people don’t like that. If I’m working hard and you’re not and you’re stealing, I’m not going to be happy about that as an honest employee. You give people a method and a means. When you’re talking to people, when you’re doing your employee training, you explain to them that this is what we’re trying to do.

Some people are not going to like it, let me say that. One of the things that I did at the Association of Certified Fraud Examiners, I implemented an internet-monitoring software where we could see what employees were doing. We didn’t turn it on until we had an all-hands meeting. I told the employees what we were doing, and I said, “A lot of you got personal email. I’m not trying to stop me from checking your personal email. I’m just trying to make the company a better place to work.”

The very first person that I had to call to task about internet usage was the director of our IT department who had installed the software. In five days, he had spent 10 hours on eBay looking for nautical-themed stuff. I’m thinking it had nothing to do with his job. We eventually terminated that person because he could not stay off of it. I don’t know what he was buying on eBay, but that man did love eBay.

Most of the people didn’t care because they didn’t spend all day on the Internet. We normally would not say anything to anyone, unless they spent six to eight hours a week on the Internet. Once again, you have to have the controls there.

Most people are not going to be necessary, but for the people that are, keep in mind you’re looking for red flags. You, the owner, the managers should be familiar with what red flags are. Change is a red flag. If you’ve got three vendors and all of a sudden you go to another fourth vendor and the other three quit getting business, that’s change. It could be if that fourth vendor is just selling product at a cheaper price.

But it also could be that me, the purchasing person, has created that fourth vendor and we’re funneling all the business through my company. I’m buying from those three people, but then I’m adding 4%–5%. You see that regularly. That’s one of the most common frauds.

One of the things I tell people in the corporations, you should have your computer system set up so that if I enter a vendor, that computer should take the address of that vendor and run a scan against all the employees. Make sure you don’t have the same address, because that’s one of the most common things people do. If I’ve created that fictitious vendor, I’ve got to have an address, and more times than not, I’m going to use my home address.

It happens time and time and time again. You never ever say the word—surely they wouldn’t be that stupid, because they will, in fact.

Has most of the fraud people perpetrating fraud that you’ve run on the financial side. Is it through creating fake vendors, or are they actually writing, stealing cash, or writing checks that have no—I try to differentiate the I’m padding; I’m padding the expenses by running it through a business I own. I’m siphoning off a little bit off the top versus just outright writing checks or transferring money.

Well, I said earlier that 80% of the frauds are asset misappropriation. You got 20% and those are broken up through financial statement fraud and corruption, taking kickbacks. One of the things that a company should do—and most of them have—is a policy that me, the purchasing officer, this is what I can take in the way of gifts, because all of the vendors have got accounts, they’ve got expense accounts to buy purchasing agents lunch, gifts, and stuff such as that. And, by and large, I find out that most auditors I want to talk to had no idea what that policy was, how much their employees could take.

Case in point, I did training this large corporation, and their policy was that their purchasing people could take $75 in either gifts or lunches. And they wanted the vendors to take the purchasing agent out to lunch Christmastime, they get them something. They thought $75 was reasonable. My brother-in-law worked for a company that it was a trucking company and he was a salesperson, and he had an expense account. Well, this trucking company had paid for him to have a membership at the country club.

I mean, they wanted that everybody wanted to play. It was Christmastime, and I went to visit and he says, “Look, I’ve got a sales or purchasing agent that I work with from this company. It was the company that I went to, said his son is in for Christmas, and he has always wanted to play this golf course.” He said, “We need a fourth. Do you want to go with us?”

So I said, “Sure.” We go to the golf course. First thing he would do is we go to the tour shop. Well, all of us walked out looking like a commercial for this golf course. I mean, we had hats, we had shirts. We went out and played eight pan holes; the worst golf you’ve ever seen. Then we went to the clubhouse and we had a steak dinner. There is no telling how much money he spent. And, I was talking to him later because my brother-in-law is an honorable person. I told him, I said, “I did some training with this guy’s company, and he could take $75 and that’s it.” He said, “Oh, we spent much, much more than that today.” He said, “But here’s the deal.” He said, “That’s his policy. It’s not mine.” He said, “I’m trying to create an environment when he needs shipping done, he feels obligated to come to me.”

So, and that’s what you run into. I had, I talked to one fraud perpetrator and he told me, he said one of his coworkers said, “Look, let’s just go to these purchasing agents and say, ‘Here. Here’s the deal. We’re fraud. We’re charging you much, much more. Here’s $10,000. We want you to approve everything we send to you.” This guy said, “Here’s the problem with that. If he takes it, we’re in good shape. It'll work good. But if he doesn’t, we’re going to lose this business and possibly go to jail. If we give him small gifts, he’s just as obligated and there’s nothing that he can report.” That’s what, where you run into a problem.

They give them the small gifts; they’re just as obligated. It’s not necessary to give them $10,000. You can take them to a golf course and take the kid out and buy him a t-shirt that says, got the golf course name on it. You pretty much got him in your pocket at that point. The kickback, now, the financial statement fraud that you mentioned in the financial part. Ironically, I go back to the 80% asset misappropriation; 80% of the losses come from financial statement fraud. It just goes around because that’s where you lose a lot of money.

Loan frauds, now generally that’s going to be the owner or senior management that does—you saw that in Enron. Yeah. Whenever the senior managers were falsifying financial statements. That's the problem. You run another thing, if you’ve got an auditor in your company, it’s really hard for that auditor to challenge that senior manager. That's something else you have to deal with. That would be about a three-day course right there.

Is that like the auditor shouldn’t report to the CFO in a sense?

Oh, by all means. They shouldn’t. The auditor’s got to be completely, totally independent. I go back to I mentioned Arthur Anderson in Enron. Arthur Anderson was reportedly making a million dollars a week from Enron. The senior managers at Enron, if an auditor, one auditor I know personally came up and challenged him on something; he was transferred off that account the next month.

They’ve definitely got to be independent and your board of directors on these, these larger corporations that have boards of directors, they should be educated on fraud. The whole thing can be greatly reduced with education. Before Enron, the Association of Certified Fraud Examiners had a fraud prevention course. Chris, to be quite honest with you, we could not give that thing away.

Nobody would be there. Well after Enron, they came up and they said, “Well, gosh. We’re going to start putting managers in jail. We’re going to start charging them for being negligent.” Well, I mean, probably 80% of the training I did was that same fraud prevention course we had before. But then whenever they didn’t do that, when the government didn’t put people in jail, when they didn’t charge people very gradually, the interest in the fraud prevention program declined. That’s the hardest part, is convincing someone that they need to spend the time and the money to educate their people.

Because you’re spending money on a negative. You’re spending money on something that nobody's stealing from us. I’ve had that happen traveling on the airplane. A lot of—I’ve got over three million miles just on American Airlines. You sit next to a lot of really interesting people. By and large, I’ve talked to managers that said, “Well, we really don’t do anything ’cause we don’t have any fraud.” I’m thinking, “Well, if you don’t do anything, Gomer, how do you know you don’t have a fraud?”

You’re not going to know until it gets so big that it topples under his own weight, like Bernie Madoff. And, and so that, that’s the problem. Once again, the average corporation is going to lose 5% of their gross revenue to fraud. I was giving a talk to a government subcommittee one time and had some of our fine elected officials in there, and I used that statistic, and one of our fine senators looked up and said, “Well, I’m sure glad the government problem is not that bad.”

It’s probably worse .

People, they don’t perceive they have a problem until it’s too late. -James Ratley Share on X

So I—that’s, that’s just it. People, they don’t perceive they have a problem until it’s too late.

So it’s really not, “Companies don’t have a fraud problem.” It’s just that they don’t know that they have a fraud problem.

They don’t know they have a fraud problem, negative information. They don’t want to hear negative information. They'll ignore that when they can. They're not bad people; that’s just human nature. Yeah. Not, not to want to dwell on the negative, but it, it comes back to it’s our responsibility to look, we, I go back to the fraud triangle. You take the opportunity away as much as you can, but then you also work to take the ability to rationalize. And you mentioned earlier that there are financial issues we, we can’t control. One of the things I did at the Association of Certified Fraud Examiners, we had a lot of employees.

We had five when we started; now they’ve got over a hundred employees. They’re young employees—of course, to me, at my age, everybody’s young, you’re young. They have the same problems I had when I was young. We have a policy at the association: if you need help, you come to us. I have paid for a number of root canals, or I have, the association has bought a number of sets of tires, car batteries. I don’t want our employees out on the road in the middle of the night with a flat tire because they had bad tires. We’re going to help our employees.

I think that is so important that you have an employee care program where they’ve got someone to turn to. Most people have got their parents or their siblings that they can turn to, but some people don’t. And I think it is a responsibility of a corporation to step up to help their employees. We didn’t make them pay that back. I mean, they already don’t have the money to have it done. I, you, you have to have an employee care program like that. I’m very proud of what the Association of Certified Fraud Examiners has done and how they treat their employees. They still do.

That was a program that Joe Wells and I implemented just because we, and, and as a result, I can’t, I’ve lost count of the number of employees that the association has that have been there over 10 years, because they realize it’s a good place to work and we care about our employees. I think especially a small business, any business, but especially a small business where the owner or the manager should know their employees, they should step up to help whenever they get their back against the wall.

Yeah. That definitely lowers the rationalization component. If they’re like, “Hey, my boss has gone out of his way to help me personally,” the whole, “I deserve this” starts to go away.

Well, it really does. It does. A lot of it comes back with knowing what your employees are doing, knowing how their job is going, going by. Joe Wells taught me this, and it was one of the most important things I learned while at the Association of Certified Product Examiners. He called it management by walking around. You walk around and you sit down with the employees and you talk to them, you know their children’s name. You know what? I have bought more Girl Scout cookies than I could ever eat in a lifetime, and I can eat a lot of Girl Scout cookies, but every time one of those people would come in selling Girl Scout cookies, I would, I would, by all means, I was there buying it because I want the employees to know that we care about them. And, and you’re right. That does, that helps cut down on the rationalization.

So I forget what those, whether it was while we were recording or before we were recording, you had said that 50% of small businesses go out of business because of fraud.

Yeah, 50. That’s according to Dr. Stephen Albrecht, former head of the accounting department of Brigham Young. Fifty-one percent of the businesses, small businesses that fail, it’s directly a result from fraud.

So was it that 80, 80% of the financial impact from financial fraud means and 20% from physical assets? Or was it for, for the ones that did go out of business, it was predominantly ’cause of one or the other?

Well, it is generally because they were operating at a loss, and the loss is a result of taking kickbacks from vendors. Once the vendors start giving kickbacks—and they, and take my word for it, the vendors know who’s going to take the gifts. Yeah. They know who is going to play by the company policy and who’s not. Once they start doing that, two things are going to happen. As a vendor: I can raise my price whatever I want. And, and two, you’re probably going to buy a lot of stuff that you normally wouldn’t buy, because you’re trying to keep me happy.

You want to go to the company hunting lodge. We’re going to take the private jet down there for four or five days. You see that I worked fraud on a construction job one time, and it was a large job. And, and I’m trying—I know there is a kickback. I mean, the company, their purchasing people had falsified the strength test on concrete. I knew they did that for a reason. I looked for every kickback I could find and couldn’t find one.

Finally I was talking to this, what, at that time, I called an old woman, and she’s probably younger than I’m now that was the secretary there. She said, “Well, have you looked at the travel log, stupid?” I said, “What travel log?” She said, and she grabs the book and just pitches it. It was the hunting lodge, and it looked like a hunting lodge for the company. That I was working for that I was trying to, because all of, all of their employees, I mean, they were taking the corporate jet to that hunting lodge, and that’s what they were that’s, that was the payback right there.

They get to go down and shoot a deer or a duck or what have you. They got to go in the company jet. That's what prompted them. That's the thing there when you, the manager or the auditor, you never, never judge those people by your standards because you’re thinking, and I’ve had people say before, “Well, I was never going to do that. They’d have to pay me a lot.” You’d be surprised how cheaply somebody will sell their souls to the devil. Just a weekend at the hunting lodge, chance as remote as it might be of future employment after I quit here, perhaps I can go to work for your company.

You see that in it, it always amazed me how cheaply somebody would sell their job. But you, you see that the 51%, it happens from buying stuff from vendors that we don’t need.  Most employees don’t have access to steal a lot of money without, without getting caught. Now, certain people do. The people that are writing the checks and you’ve got the owner of a small business should have the bank statement sent to him or her. They should look at that regularly. Yeah. I’ve got a, a friend of mine that came to me the other day. He has a sausage company, and it’s a huge company.

He’s probably got 80, 90 employees and, and they just cut a huge deal with one of these Sam’s Club or whatever—I don’t remember the name of it. He said, “What should I do to make sure someone’s not stealing from him?” Because he is semi-retired. He’s still taking the money, goes in two days a week. I said, “How long has it been since you looked at a bank statement?” He said, “I don’t remember ever looking at a bank statement.” “That’s how they get money out of your company. You should be looking at that bank statement. You should be looking at the vendors you’ve got with Google Earth.” Now if you’ve got a question about a vendor, when, when they enter a vendor in my system, I want to make sure they have a physical address.

Someplace I can go drive by and look at if I want to. And another thing: you need to let the employees know that you’re looking. Yeah. And, and a lot of times—and I tell people this as my area of expertise is interview and interrogation and how to tell if someone’s lying whenever you talk to them. About half the questions that I ask someone I already know the answer to, I’m asking just to see how you’re going to react to the question and what information you’re going to gimme. As a manager, when you go to these employees and you ask questions, probably a third to half of them, you already know the answer.

Another thing you’re looking for is the documentation or the documents there are. Are you giving me the documents I need to recreate that transaction?  Because after I discover that you’re stealing, it's too late to get those documents, the manager, and see if you’re documenting that as you should. I’m also looking for anomalies. Things that, in my expertise, you shouldn’t have. One of the things I look for is even amount expenditures, and, and people steal in, in even amounts—a thousand dollars, 5,000. I’m familiar with, with one case where a manager came in and he asked the employee what this $15,000 expenditure was.

The employee said, “Well, that’s a tax payment that I had to pay.” All the manager said was, “Well, that’s unusual. You normally don’t see an even amount like that.” The manager walked off. He honestly didn’t think anything else about it. Two hours later, the employee came in and sat down at his desk and was crying and saying, “Well, I guess you’ve caught me.” I don’t want the employees to know what I know and what I don’t know.

I always have thought the reason teenage children act the way they do is so that, as parents, you won’t try and keep them in the house when they get ready to leave. But my daughter came to me one time and said, “Daddy, do you know how to keep a geek in suspense?” I said, “No, I don’t.” She didn’t say anything. I said, “I don’t.” She didn’t say anything. I said, “Well, are you going to tell me?” She just went to laughing and walked off. It took about two days before it really hit me what she had done to me. When you go to these employees and you ask them a question, you want to keep a geek in suspense. You don’t let them know what you know and what you don't know.

It’s funny that you mention the whole numbers or even numbers. In my mind, when you said that, I was thinking back because I have a small business. I do all my accounting. I started thinking through. I’m like, “That, that’s true. The only thing that is a whole number is when I get that if I’m taking money out of the business.”

Exactly. That’s it. So many times after I go in and show the owner the books they’re thinking—and they, they’ve said—“I’ve seen that. I just never thought about it.” Another thing that I try to tell managers: If you have a feeling, if you look at something and you have that, that first thing you think is, “Gosh, that’s unusual,” then you need to find out why you thought that. You need to go look. And, because most of the time it’s not going be anything, but sometimes you, it’s that thread that allows you to unravel the entire garment. You start pulling on that and it just gets worse and worse. So anything that causes you to raise an eyebrow to look at, it’s you. That’s what you do as a manager.

That’s why they pay you that extra money and give you the nicer office and stuff. It's something that you are responsible for and your obligation has got to be to that organization. And, you're helping the employees by keeping that organization strong. Once again, I could talk, I mean, I can talk on this all day long. One of my pet peeves is managers that don’t manage. There are so many things that they should have seen, they should have known. Anytime you catch yourself saying, “It’s probably alright,” you’re making a horrible mistake. Look for that thing that causes you to raise the eyebrow.

That’s awesome. As we wrap up here, any passing advice for small business owners?

Yeah, I’d say be involved. Know your business. Be there and, and look at the paperwork. Look for the anomalies. Hold your managers accountable. These people—one of the big downfalls that I see, they become friends with managers, friends with employees, and they’re hesitant to confront them. That could cost you your business. Be a business owner first, or a manager first, and a friend second.

That’s good advice. Jim, thank you so much for coming on the podcast today.

Thank you very much for having me, Chris. It’s been my pleasure.